As The Tri Polar World Turns: Confusion By Extrapolation

EXECUTIVE SUMMARY

Investors have suffered through a very tough month with few places to hide as even recent winners like commodities get hit. 

Those, like us here at TPW Advisory, who have been constructive, are battered & bruised, left to question their POV.

Yet while investors price in multiple unpleasant scenarios, the outcome remains in doubt as range trading equities indicate uncertainty as to which way the economy will go. This makes perfect sense given the rolling waves of uncertainty generated by our 3 Cs: Covid, Climate & Conflict.

Multiple examples of dissonance between economic data, asset price action and future expectations across asset and economies suggest extrapolation at speed is not advised.

We expect our inflation fever break thesis to play out across both the US and EU in coming months, creating the potential for sudden price reversals across assets. Earnings, low real yields, stable credit among others keeps us constructive on risk assets.

CLIMATE

Tesla, the company and TSLA the stock, have been a great micro laboratory for the macro confusion we see across the Tri Polar World. 

Excellent operating and financial results have been insufficient to offset the macro uncertainties surrounding CEO Musk’s bid for Twitter. 

ECONOMICS

Investor confusion is best expressed by coincident pricing in of sharp rate hike cycles on both sides of the Atlantic together with recessions, this year in the case of Europe, next in the US.

Neither seem accurate as slowing growth is not slow growth, as we have noted for months, nor does it suggest recession. Q1 EU GDP growth came in at 4% y/y while the April PMI Composite was the best since September. US Q1 GDP headline # seems worrisome but is belied by strong consumption and cap ex spending.

Ever higher Inflation readings should rollover in the months ahead in both the US and Europe as energy prices are down anywhere from 50% (EU Nat gas) to 25% (Brent) from invasion peak levels while base effects should help – especially in the US.

FX doom loop fears in Japan and China seem off base; Japan is likely to welcome some inflation while China currency weakness reflects foreign investor selling, not domestic money fleeing.

POLITICS

Neither Pres. Putin nor Pres. Xi seem ready to turn from the misguided invasion decision or the more debatable Zero Covid approach to Omicron. Time is not Putin’s friend. Shanghai Covid cases at one month low suggest Xi may have the easier time of it.

EU integration continues to deepen with French and Slovenian election results, newly agreed Digital Market and Digital Service Acts both being run by the EC.

POLICY

The 3 Cs continue to ensure a greater role for Government spending today and in the years ahead. Investors need to take on board a higher nominal growth world, one quite different from the post GFC decade that preceded the Covid era.

Fed jawboning has succeeded in having markets price in the fastest and most aggressive tightening cycle since 1994 – note that 1995 saw easing. Soaring mortgage rates, weak equity markets coupled with Covid’s ebb unsnarling supply chains and easing labor concerns should cool off inflationary pressures.

US Core PCE inflation has peaked, marking the first decline since October 2020. We expect bigger declines in the coming months.

Europe should decide shortly whether to embargo Russian oil exports; Germany has been able to reduce Russia’s share of its oil M from 35% pre invasion to 12% today and no longer resists such an embargo. EU Nat gas and Brent crude prices remain well behaved.

Fiscal policy is likely to feature in coming months across both Japan and China. Japan will introduce new fiscal measures while China’s Politburo has committed to supporting growth at targeted levels. Action is needed.

MARKETS

Global equities reflect poor technicals, sentiment as bad as it has been in the 30-40 years, extremely light positioning and high volatility. Oh and BTW, earnings are coming in BTE led by high single digit sales growth across the US, EU and Japan as the high nominal growth world manifests.

Bonds have been left for dead and may be worth a tactical look as our inflation fever break thesis develops. Credit remains the dog that hasn’t barked for the uber bears.

Commodities has been the big winner ytd, even in the face of a strong USD run. We see pullbacks across the complex as opportunities to buy dips in a secular bull market, especially in the mining and energy spaces.

We have been wrong about the strong USD that has left the Euro approaching parity, the Yen at 20 yr. lows and investors speculating about a big China Deval. We see the latter as highly unlikely. 

An inflation fever break should lead US rates lower, cool off the USD and help reestablish interest in some of our favored areas like European equity, Thematic and Disruption spaces, parts of EM equity and Commodities.

April has been a tough month but sometimes its darkest before the dawn. 

Enjoy this BTV clip from Monday where I lay out my China view.